HG EXPERTS
Legal Experts
Directory
May 9, 2012 By Sam Susser
A view from a former IRS Agent, CPA, College Professor
Welfare Benefit Plans (WBP), also known as Welfare Benefit
Trusts and Welfare Benefit Funds are vehicles by which employers may offer
their employees and retirees with certain types of insurance coverage (e.g.,
life insurance, health insurance, disability insurance, and long-term care), as
well as other benefits such as severance payments and educational funding. If
properly designed and in compliance with IRC sections 419 and 419A, WBPs offer
employers with a valid tax deduction. However, as is the case with many plans
that offer opportunities for deductibility, some WBPs fail to comply with Code
standards, invite abuse, and otherwise are used inappropriately as a basis to
reduce taxable income.
It is, therefore, not surprising that the Internal Revenue Service (IRS) has
targeted WBP, designating many such plans as “listed transactions.” The IRS’
attack arsenal includes, but is not limited to: Notice 2007-83 (where the IRS
intends to challenge claimed tax benefits meeting the definition of a “listed
transaction”); Notice 2007-84 (where the IRS may challenge trust arrangements
purporting to provide non-discriminatory medical and life insurance benefits,
if such plans are, in substance, discriminatory); Revenue Ruling 2007-65 (where
the IRS will not disallow deductions for such arrangements for prior year tax
years, except to the extent that deductions have exceeded the amount of
insurance included on the participant’s Form W-2 for a particular year), and
IR-2007-170 (the IRS’ guidance position on WBPs). Accordingly, taxpayers who
have claimed deductions pursuant to Internal Revenue Code (Code) Section 419 are
receiving letters from the IRS inviting them to an audit.
THE GOOD:
Let’s start off with a proposition that may surprise many of you – the IRS is
generally good. No, that’s not an oxymoron. The rest of this article is in the
words of Sam Susser:
For over 35 years, I have had the privilege of representing the IRS and the US
taxpayers on tax audits. Our goal was to always determine the correct tax
–whether the outcome was a deficiency or a refund. The bottom line, which the
IRS supported, was to “do the right thing.” Over these years, I have met and
befriended many competent and exemplary agents. As with all industries, there
are a few who simply go through the motions, and there are a few who are simply
incompetent. Fortunately, the latter two groups are in the minority. Now that I
represent clients who are being audited by IRS, my objectives have not changed.
The right thing must still be done. I only hope to get a well-versed agent who
knows the law and can make a determination based on facts and circumstances,
and not by preconceived notions.
I have been resolving the WBP issue mostly at the Revenue Agent (RA) level.
Most RAs are knowledgeable in the area of WBP, and it it a pleasure dealing
with them. My clients became involved with both abusive plans as well as what I
determined to be non-abusive plan. Because most clients have sought the
opinions of an independent professional tax attorney, CPA, Enrolled Agent , or
other independent professionals who the IRS deems to be knowledgeable and
capable of rendering an opinion on a Plan, Prior to 2007 I had a good case for
abating the penalty and any interest thereon due to the reasonable cause
exception. The RAs accepted my briefs for penalty relief and I usually resolved
the case agreed at the agent’s level. The right thing was being done by both
sides. Since 2007 the bar has been raised in meeting the reasonable cause
exception. Simply put, if taxpayers failed to file Forms 8886 with their tax
returns, the penalty could no longer be abated due to reasonable cause. If we
do not come to an agreement, the case would, at taxpayer’s additional expense,
proceed to the Appeals Division. This would normally be a good strategy in
nebulous circumstances. With rare exceptions this is not a good strategy under
these circumstances as explained later.
Just as there are good and bad IRS agents, there are good and bad WBPs. The
abusive plans that have been sold should not affect those plans that adhere to
the spirit of the tax laws. Thus, of the many plans sold to taxpayers, some can
be considered “good.” The “bad” WBPs should not taint the “good” ones.
IR-2007-170, Oct. 17, 2007, recognizes that “[t]here are many legitimate
welfare benefit funds that provide benefits, such as health insurance and life
insurance, to employees and retirees. However, the arrangements the IRS is
cautioning employers about is primarily benefits the owner or other key
employees of businesses, sometimes in the form of distributions of cash, loans,
or life insurance policies.”
THE BAD:
A persistent pattern that I see with WBPs is that the IRS appears to
presumptively hold such plans as improper contrary to the statement in
IR-2007-170. From what I have indirectly encountered, it appears that the IRS
may interview the plan administrator, with the primary objective of securing
the plan’s participants (and audit targets) rather than determining whether the
limitations of a Code Section 419 deduction were satisfied. No determination is
made as to whether the plan meets or fails to meet Code requirements. The plan
participants then receive audit letters: one to the entity claiming the
deduction, and the other to the owner(s) of such entity. These audit letters
are generally accompanied by a lengthy “canned” Information Document Request
(IDR) ostensibly written by IRS attorneys.
During my decades with the IRS, IDRs are usually focused documents seeking very
specific documents and information to determine whether further action is
required. However, my review of IDRs on the subject of WBPs shows them to be
akin to document production demands in a civil litigation. The IRS basically
wants everything associated with the WBP – there is no specific focus.
Moreover, they have a very expansive definition of documents, and seek them
whether they are in the taxpayer’s possession, or in the possession of the
taxpayer’s “attorneys, accountants, affiliates, advisers, representatives, or
other persons directly or indirectly employed by you, hired by you, or
connected with you, or your representatives, and anyone else subject to your
control.”
What was most disturbing about these IDRs that I have seen is the fact that the
RAs also have, on a number of occasions, requested copies of the tax returns
for the tax year(s) under audit. This indicated to me, especially since the
name of the WBP is repeatedly mentioned in the IDR, that my client was selected
from the list provided by the plan administrator to the IRS. This in itself is
not necessarily bad since this is a useful tool for the IRS in obtaining names
of participants of plans that might not meet the muster of the Code and IRS
pronouncements. However, I would think that the “give me everything from
everybody” approach should not be the first step in an IRS inquiry into the
validity of a WBP.
Other clients received audit letters with a similar IDR requesting information
including copies of the returns under examination. These clients, however, had
stopped participating in the plan many years prior to the audit years.
Nonetheless, since the client's name was still on the Plan’s list of
participants, the client was going to be audited. The IRS takes the position
that the cash surrender value of any life insurance policy in the plan is
available to the client and is therefore income to that client for the year the
IRS has decided to audit Accordingly, the RAs are proposing adjustments in
years in which no deduction to the WBP have been taken.
THE … ?
To rub salt into the wound, the RA has enclosed an explanation as to why the
deduction is disallowed, and has proposed a statutory underpayment penalty. The
tax law provides for a penalty to be imposed where a taxpayer makes a
substantial understatement of their tax liability. For individual taxpayers, a
substantial underpayment exists when the understatement for the year exceeds
the greater of ten percent of the tax required to be shown on the return, or
$5,000. This is a relatively low threshold and is easily met by most taxpayers.
The penalty is twenty percent of the tax underpayment.
Following the RA’s review, the taxpayer can expect to receive a 20 – 40 page
“boiler-plated” or “canned” write-up, which will wind up as the Revenue Agent
Report (RAR). The RARs that I’ve seen appear obviously drafted by IRS
attorneys. Sometimes the RAR is shortened as a result of “cut and paste” procedures
assembled by the RA. The RARs also contain alternative positions for these
proposed disallowances. Taxpayers and representatives can take little comfort
when all indications lead to the conclusion that the IRS has made a
determination prior to assessing all the facts and circumstances of any given
case standing on its own merits. My concern is that the WBP that meet IRS
requirements are swept together with those that do not, and are unjustly
branded as “bad.” The participants of these “good” plans must now overcome the
preconceived notions of the RA. This becomes a difficult task as RAs won't
deviate from the “boiler-plated” positions, forcing the taxpayer to expend
funds in seeking further relief . The Appeals Division has similarly received a
directive to sustain the RA RAR thus effectively eliminating the appeals right
the taxpayers normally have. The only "appeals" route a taxpayer can
take is to petition the Courts for a hearing. The time, expense, and outcome in
defending a WBP under this scenario are enigmatic (hence the “…?”), and well,
simply put, can really become downright UGLY!
CONCLUSION:
The IRS needs to examine WBPs on a plan by plan basis, and make a determination
based on the facts and circumstances of each plan. Specifically, they should be
charged with independently evaluating whether a particular WBP generally
adheres to the Code and the IRS’s issued pronouncements. The RA and those in
charge of this project should be cognizant of the statement issued by Donald L.
Korb (Chief Counsel for the IRS): “The guidance targets specific abuses
involving a limited group of arrangements that claim to be welfare benefit
funds.” (emphasis provided). He continues to state that: “[T]oday’s action
sends a strong signal that these abusive schemes must stop.” (emphasis
provided). For those plans that the IRS deems to be abusive, the IRS can
concentrate its resources in auditing the plan participants. The IRS hierarchy
needs to eliminate the UGLY, recognize the GOOD, and pursue the BAD.
--
ABOUT THE AUTHOR: Sam Susser
Sam Susser began his IRS career on 2/1/71, and spent most the succeeding years
as an international examiner with brief stints in the Review Section and the
Appeals Division. He closed out his IRS tenure spending four years as
International Team Manager for South Florida. Currently Sam is in private
practice and can be reached at 561-742-1005
The information provided herein is not intended
as legal, accounting, financial or any type of advice for any specific
individual or other entity. You should contact an appropriate professional for
any such advice.
Copyright
Lance Wallach, CLU, CHFC
